One solution to Citigroup's woes

Commentary: It starts with a 'B' and ends in 'reakup'

By

ThomasK. Brown

NEW YORK (Bankstocks) -- Citigroup at last closed on its deal to acquire Grupo Cuscatlan, "one of the leading financial groups in Central America, with operations in El Salvador, Guatemala, Costa Rica, Honduras, and Panama," according to the press release, for $1.5 billion in cash and stock.

I can't say that I'm scrupulously familiar with every detail of Grupo Cuscatlan's business -- actually, I've never heard of the company -- but I assume that $1.5 billion is a fair price for a leading financial group that operates in five different countries, even if some of those countries aren't any bigger than Delaware. The people in the executive suite up at 399 Park must be very pleased to have laid this newest acquisition onto the wall of their global financial monolith.

You've never heard of Grupo Cuscatlan, either? Don't worry. My guess is that when the deal was announced last December, nine of 10 (or maybe 99 of 100) of the analysts that cover Citigroup
C, +1.23%
hadn't heard of it, either. Most of them still might not have: I only found one First Call note from Lehman Brothers that even commented on the deal back after it hit the tape.

If the stock continues to lag, the grumbling will start in earnest. And once it does, I'm willing to believe that anything could happen.

The reason I mention this is that I believe that Citi's acquisition of Grupo Cuscatlan is as good a piece of evidence as you're likely to find that the company needs to be broken up, and the sooner the better.

Look, I have no idea whether the Citi's Cuscatlan coup is a brilliant deal or not. But I do know that no management on earth, no matter how smart, can knowledgeably allocate capital across the vast universe of alternatives Citi has carved out for itself under its current strategy.

Even without looking at my cue cards, I know the company is lately shoveling money into: a) Central American banks, b) a UK money manager, c) a mishmash of green initiatives, d) bank branches in Boston and Philadelphia, e) a network of Russian consumer-finance offices and f) a U.S. mutual-fund administrator.

Now tell me. How can a single organization know enough about all that stuff to optimally invest capital in each and every one of its businesses and not get snookered?

Answer: It can't. This is why, in the financial services business, small-and-focused beats big-and-far-flung just about every time. Pick any area. In deposit-gathering, community banks consistently take share from the big nationals. Specialized mortgage lenders have been trumping generalists for the past decade. Ditto auto lenders.

So the best way for Citi to boost its returns would be to make itself smaller and more focused by spinning out its constituent businesses to shareholders.

The back of my envelope comes up with four standalone units that could be pretty strong competitors: consumer banking (let's call it Citicorp), investment banking and trading (Salomon Brothers), wealth management (Smith Barney), and international ("Citiglobal"). Give each of those units a peer multiple (all of which would be above Citi's current P/E of 10 times, by the way) and the package is worth $60 or so per share, vs. the stock's recent price of around $53.

But more to the point, each of those four businesses would be a stronger competitor on its own than it is now. They'd all be rid of at least some stultifying bureaucracy that goes with any mega-company, and would be in a better position to recruit talented people who'd know they'd be involved in their employer's core business. The units wouldn't have to jostle for capital with each other within the old corporate parent.

Plus, it's not as if Citigroup as currently constituted is a paragon of management expertise. The company has gone through three CFOs in the past three years, for goodness sake, and most recently had to recruit one from outside the company. Chuck Prince, a lawyer by training and background, is no one's idea of a towering figure in banking. As to the company's culture, it basically doesn't exist. Citigroup is essentially a grab bag of acquisitions thrown together over the past 20 years. The units have next to nothing in common -- nor should they. That's one reason the businesses seem to have chronic compliance issues.

Will a breakup happen anytime soon? Stranger things have happened. Certainly, activist investors have more clout than they used to, and haven't been shy about going after some big targets. (If memory serves, Ralph Whitworth, of the activist hedge fund Relational Investors, was able to help effect the exit of Bob Nardelli after accumulating just 1% of Home Depot.)

I have no idea whether activists are eyeing Citigroup now. The good news on that front is that ESL's Eddie Lampert, who knows a thing or two about reviving corporate fossils, just disclosed his fund owns 15 million shares of Citi, having added to the position in the first quarter. The bad news is that those 15 million shares add up to just 0.3% of Citi's share count. See related story.

But Lampert is the kind money manager who gets a lot of respect from both investors and company managements. If he starts making noises, people will listen.

As it is, Chuck Prince has been under some pressure from some of the company's largest shareholders. If the stock continues to lag, the grumbling will start in earnest. And once it does, I'm willing to believe that anything could happen.

Thomas K. Brown runs Bankstocks.com, which provides free research and commentary about the financial services industry. He is also the portfolio manager of Second Curve Capital, a New York-based hedge fund that invests in financial services stocks, and frequently writes about his investments on the Web site. Neither Brown nor his hedge fund currently holds shares in Citigroup. (Bankstocks.com)

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